The right tenant mix for your commercial property

Commercial properties can host a variety of different tenants. What makes the property successful for both landlord and tenant will be whether the tenant mix works for everyone. “A question often asked by investors when renting out premises,” says Leon Breytenbach, National Manager of the Rawson Property Group’s commercial division, “is, ‘What is the ideal mix of tenants for my commercial property?’” National tenants, comprising large companies found nationwide, are considered ideal tenants because they are household names, e.g. Pick ‘n Pay, Shoprite, Mr. Price, etc., but they carry a cost. Due to their wide customer-base, attracting large numbers of consumers, national tenants often demand a lower rental. Similarly, office based tenants which are strong, secure and reputable, will expect a similar reduction.

When a national tenant demands a lower rental, this reduces the return on the property. “There is a trade-off, however,” says Breytenbach, “as you gain greater confidence and stability in your tenant base and therefore, in your income. When a national tenant occupies a commercial property,other tenants in the same property will pay a higher rental as a means of offsetting the lower rental offered to the national tenant.” In Claremont, for example, current rental rates for a commercial property are about R180 per square metre for stand-alone premises, but near a national tenant the cost may rise to R220 or R250 per square metre, while in exceptional cases rent has been known to go as high as R500 per square metre.

National versus non-national

Every investor wants the best return from his property but to achieve this he needs to include an element of risk. This can be provided by a non-national tenant prepared to pay higher than market related rentals in order to be near a national tenant. These non-national tenants carry a greater risk than national ones as they lack the stability, reputation or financial strength of the larger entity.

“The ideal scenario,” says Breytenbach, “is a mix of tenants who provide a secure income source being as close as possible to market related rentals.” Thus one must combine a national tenant providing stability, with higher paying non-national tenants in order to maximise the return generated on the property.

Some possible scenarios

Take a commercial property of 500 square metres, 100% occupied by a national tenant at a rate of R100 per square metre, which provides an income return of R50 000 per month. This scenario is an example of  the best stability option but with the lowest income.

The second scenario uses the same property of 500 square metres, having a 75% national tenant occupancy at R100 per square metre while the remaining 25% is taken up by a non-national tenant paying R140 per square metre. The income return would be R55 000, made up of R30 000 from the national and R17 500 from the non-national tenants. This combination provides a little more income but greater risk due to the inclusion of the non-national tenant.

The third scenario, again using the same property of 500 square metres, now with a 60% occupancy by a national tenant, still at R100 per square metre, while the other 40% is taken by non-national tenants paying R140 per square metre will see an income return of R58 000. This is made up of R30 000 from the national and R28 000 from the non-national tenants, thus offering the best return but the highest risk.

Valuing the property in scenario one, it would have an excellent capitalisation rate. Scenario two would attract a similar rate due to the larger occupancy of the national tenant. By including 25% occupancy of non-national tenants, the value is increased as the income is greater. In the third scenario, the capitalisation rate would not be as good.

These scenarios rule out industrial properties, mainly occupied by a single tenant, while office and retail premises lend themselves to mixtures and combinations.

South Africa is an entrepreneurial country having many emerging businesses which causes increased demand for premises, both retail and offices. Therefore, should one non-national tenant within a commercial property fail, there are many more waiting to replace it, particularly if the location is close to a strong national tenant. This is because good passing trade is guaranteed and the location lends credibility to the non-national tenant. “Ensure, when compiling your tenant mix,” says Breytenbach, “that your choice of tenants will complement one another. So we see that the element of risk within a portfolio maximises the return, while confining it within sensible boundaries.”